The Nifty continued to strengthen and reached new highs during the month. It is also a rare month when markets were up despite the fact that foreign investors sold nearly $ 1 billion. In the absence of excitement in the real estate market and gold, domestic inflows into mutual funds have been robust and have absorbed any FII outflows.

Among the few key asset classes where investors can deploy their capital (equity, real estate and fixed income), equities have clearly performed well over the past several years, in addition to being tax efficient. Fixed income (debt) on the aggregate, has delivered returns less than inflation, especially after tax. An average Indian’s portfolio is much more loaded towards debt than equity, and this drags down the inflation adjusted post tax return of the aggregate investments.

Further, research suggests that even within equities, what an investor gets as return may vary widely from the underlying return of the market. A recent study by Dalbar on the US markets shows that over the past 30 years while the S&P 500 has delivered 11.1% pa, individual investors who invested in the US equity market during the same period made only 3.7% pa. The reason for the discrepancy is the aggregate investor’s desire to “time the market”. More money came into mutual funds and other such products during ebullient phases of the market and sadly money left the market during dull or ‘bear’ phases. The net result was that investors in aggregate made significantly less return than the underlying market return. Study results are similar for shorter periods also.

It is important to understand this behaviour, as it affects us all, and try to figure how one can counter this. Evidence suggests that investors don’t have the confidence to invest in equities when the sentiment at large is negative, and tend to buy into equities when everything looks bright. On the other hand, valuations are cheapest when sentiment is negative and expensive when sentiment is positive. As a result, investor returns are widely different from long term market rates of returns.

Sentiment in the equity market is governed by a wide variety of macro factors, which are very hard to decipher for even very smart people. However it is much easier to understand the micro factors which affect the long term prospects of a business and that is our area of focus. Of course, one can’t completely ignore the macro – one needs to monitor the environment for specific changes which can have an impact on businesses that one owns. However, a large chunk of the news that one reads and hears is just noise which needs to be ignored.

‘Be greedy when others are fearful, and be fearful when others are greedy’ are very wise words but it is easier said than done – even the best of investors have a tough time living up to these words. One way to handle this is to focus on proven businesses which have a sustainable competitive advantage, and have sufficiently long visibility of growth. Once there is a very high level of confidence in the underlying business and its long term prospects, our experience suggests that it is easier then to ride with the times, good or bad, and thereby reduce the risks of the costs associated with a frequent churn in one’s investments as described in the Dalbar study. So, before you commit capital to any equity strategy, ask yourself if you are confident that you can commit to the strategy through good times and bad.

The Nifty was up 18.6% this financial year, but when we see it in the backdrop of a negative 8.9% return last year, it translates into a 4% per annum return over the last 2 years. The Nifty has been range bound since January 2015 and the market continues to be very stock selective. The capital goods cycle has been subdued for some time. The historical baggage of bad debts continues to affect the balance sheets of banks and this has had a concomitant impact on the incremental lending by PSU banks. Corporate revenue and profit growth over the last 2 years has been slower than its own historical growth trajectory.

On the other hand, we have also seen positive news building up steadily over the past 2-3 years, which should form a basis for a long term economic recovery. Lower inflation, and therefore lower interest rates, are now a reality. About 20 years back, infrastructure projects (like the Mumbai – Pune expressway) were getting funded at rates close to 16% pa. Similar projects can get funded at rates close to 7-8% pa, if they were to get implemented today. Such a large fall in rates makes many projects viable, and low rates are an essential precondition for a larger infrastructure project roll out. Consumer purchases, like homes and other consumer durable goods, will benefit from lower interest rates. With reduced stimulus and more efficient subsidy delivery systems, fiscal deficit is under control – and therefore there is a realistic possibility of low interest rates continuing.

Over the last couple of months, FII investments in India have picked up, with FIIs investing nearly Rs 27,000 cr in Indian markets in March 2017. Overall, investor confidence has increased, partly led by the election results in UP. The election results suggest a greater probability of the party in power continuing beyond 2019, leading to increased probability of policy stability. Equity markets love stable policies, especially so if they are pro development. The current electoral trends portend stability over the medium term.

Many of the key measures taken up by the government will have far reaching positive impact over the coming years. The new GST regime, which is being rolled out later this year, will lead to huge efficiency gains across the country. Recent moves, like providing interest subsidy to middle income housing has a huge multiplier effect on the economy. There have been some positive developments with regards to ease of doing business. Ability of the PSU banks to lend is a key bottleneck, and hopefully we should see some resolution to the bad debt problem soon.

Though equity markets have been consolidating over the past two years, and growth for companies has been relatively muted compared with their own historical rates of growth, we believe that the setup conditions are favourable for sustained long term economic growth. Not only is the Indian consumer on a favourable wicket (with lower consumer prices and lower interest rates), but the government policy environment is progressive and increasingly likely to continue.

The budget for 2017-18 presented by the Finance Minister, has made an interesting provision with respect to properties that are not self-occupied. Until now, if one purchased a second property (i.e. other than the one that was self-occupied), one could charge all the interest on the loan taken for that property against the rental income and this expense could also be set off against other heads of income like salary, business, etc. As per the provisions of this budget, the amount of interest that can be charged off against your income in the above example has been limited to Rs 200,000 per year which is at par with what it is for a self-occupied property.

At the same time, the government has given self-occupied affordable housing a big push by giving a 3 and 4% interest subsidy for all loans of individuals who are below a certain income threshold. This is given as a direct cash transfer from the government into the borrower’s account. This is however applicable only for property that is 30 sq m of carpet area in metro cities and 60 sq m in non-metros. Moreover, affordable housing has been granted infrastructure status and there are significant tax benefits for developers of these properties. The idea seems to be to encourage home ownership especially for the middle class households, but discourage investment and speculation in higher priced properties for the purpose of earning rent and property appreciation.

The property market in India has been going through a dull phase, with very limited price appreciation over the last 2-3 years – a big come down from the heady years, when double digit price appreciation was the norm. This move by the government to limit the tax benefit for the second property, could place a further dampener on property prices and discourage speculative investment in the property sector. Moreover, the real estate sector continues to face the drag of high inventory of unsold properties.

At the same time, we have seen a big reduction in the interest rates being offered by banks for fixed deposits. The dice was anyway loaded against fixed deposits since the post-tax return on FDs barely keeps up with inflation. The reduction in interest rates tilts the balance further away from putting money into FDs.

One of the big beneficiaries of the reducing interest rates have been debt fund holders, particularly those who are invested in debt funds that have a longer duration of assets i.e. longer tenure debt securities. The greater the rate cut and longer the tenure, higher is the positive impact of an interest rate cut. Interestingly, equity is an asset class which has the longest duration because there is no redemption – it is permanent in a sense. Hence equities can be expected to be the biggest beneficiaries of an interest rate cut. With alternative asset classes like debt and property on a weaker wicket, it is likely that equity products will attract larger inflows and this has also been the case with domestic mutual funds seeing an inflow of roughly $10bn per annum over the last 2 years. Having said this, investors would do well to look at the individual valuations of the stocks that they own as it is a very stock specific market.

Many equity investors often wonder about the raison d’etre of the stock market – does it add value to society or is it just a place where scraps of paper trade at some price. One of the main objectives of the secondary market, where stocks get traded among different investors, is the primary market, through which companies raise money from investors.

There are several reasons why a company may decide to get listed. A large number of companies have been funded by venture capitalists or private equity investors. These investors typically invest at an early stage and can get potential liquidity for their investments through a listing of the stock in the public market. Another possible reason could be that the promoters may want to create liquidity for themselves and other shareholders. Sometimes companies go public because they want to grant ESOPs to their employees and the listing provides a way for employees to exit at a time of their choice. The most common reason though, is to raise equity funds, the size of which it is no longer possible for the promoters, or other private means, to contribute on their own. The existence of a healthy primary market (where companies raise money through a public issue for instance) is vital for the growth of the corporate sector and is a sign of the health of the capital market.

After being moribund for a few years, we have, over the last 18 months seen some pick up in the primary markets, though the numbers still remain way below the figures observed in prior years such as FY2008 and FY2010-11. It has been observed that primary market activity picks up during bullish phases of the market. This happens because the secondary market is placing a high price on existing listed stocks and this prompts companies to choose such times to approach the primary market. What is to be remembered here is that the timing of a primary market issue is dependent on the seller of the stock, and not on the buyer, and therefore sellers are likely to choose a time that is favourable to them. However as time passes, either because of price correction, or growth in earnings, these issues can become attractive for a patient investor.

We have seen activity pick up in the primary market and have recently seen issues from a wide variety of issuers such as insurance companies, stock exchanges, HR services, pathology labs and retailers, to name a few. This lends greater depth to the stock market as a greater variety of businesses get traded on the exchanges offering more choice to investors, including ourselves.

Most of the companies in which we invest, generate free cash flows on a regular basis – hence their requirement for money from outside sources is small – they are usually able to manage their capital requirements either from internal sources or through a small quantum of debt, if the need arises. We are fortunate that some of these companies did approach equity investors at some point of time, either for regulatory reasons or to create liquidity for some shareholders and thereby, provided us and other investors with an opportunity to buy into these businesses. We continue to hope that more good companies in varied businesses will find their way to the primary market and thus allow investors to participate in their growth.